Home > A1, Learning > More to Lemonade Than Just Lemons

More to Lemonade Than Just Lemons

In Economics class one day, we took a trip town to Mr. O’s good ‘ol lemonade stand. In this hypothetical activity, we examined a lemonade stand in detail from an economic standpoint. Something as simple as a lemonade stand remarkably represents a business from an economics point of view and starting with this simple example helps to understand multiple important aspects of a business.

ImageThe details of the stand given to us were that you have decided to open a lemonade stand in your neighborhood. Out of some boards, nails, and paint you build your stand at a cost of $20. You buy a cooler to store ice for $10. You do a bit of research and learn that paper cups, ice, lemons, sugar, and water are going to cost 25 cents per cup of lemonade. You decide to sell lemonade for 50 cents a cup.

From that simple hypothetical, we began by examining the fixed costs. Fixed costs are the cost that does not change no matter how much of good is produced. In this instance, they may be referred to as “startup costs”. The fixed costs in the lemonade stand were comprised of the boards, nails, paint, and the cooler. No matter what, these costs are not going to change even if the amount of lemonade sold per day fluctuates. These costs are set and are an immediate “consequence” (so to speak) of starting up a business. The fixed costs are the inevitable implementations of the beginning of a business thus earning their nickname “startup costs”. Using the fixed costs as a starting point of the business, we moved on to variable costs.

Variable costs are costs that rise or fall depending on quantity of goods produced. The cups, ice, lemons, sugar, and water, and even the lemonade itself are the variable costs in Mr. O’s lemonade stand. The variable costs get their “variable” because for each cup of lemonade the cost for the seller is going to be 25 cents. Each day, the producer is not going to sell the same quantity of goods (lemonade) so his production costs are going to differ. If he sells 25 cups he will lose $6.25 to variable costs (.25 * 25), the next day the producer could sell 100 cups costing him $25. The variable costs vary from day to day as demand varies. Thus the variable costs are factored into a business plan with regards to how much of the good is sold.

How many cups of lemonade must be sold in order to break even? What does a business have to do in order to begin making a profit? In economics terms, you break even when the marginal revenue is equal to the total costs, or the fixed costs plus the variable costs. In the hypothetical, our fixed costs were $30 and are variable costs were $.25 for each cup produced. Our marginal revenue, or the additional income from selling one more unit of a good, sometimes equal to price, was $.50 cents for each cup sold. From there it was a math equation…

Let x=cups to be sold in order to break even.

Marginal revenue=fixed costs +variable costs

.50(x)=30+.25(x)

.25(x)=30

x=120 cups

Break Even

Break Even

Though a simple example, the lemonade stand represents the reality of breaking even in a business. Mr. Ostroff used the example of an actual drivers ed business idea being put into practice. Using his fixed costs and his calculated variable costs, he was able to evaluate the amount of students that would make his marginal revenue equal to the amount of his total (fixed and variable) costs. This simple equation can be applied with slight alterations if the fixed costs differ from the first year (permits, etc.) but is a simple equation that calculates how you start making profit in a business!

We continued to examine how to react to different situations in a business. We examined shut down decisions and whether or not it would be appropriate to close down the lemonade stand. If the weather was cold and rainy and your variable costs were more than your revenue, you should shutdown production. That is when you aren’t selling enough cups to cover the cost of making them you are simply losing money. This again is applicable to any modern day business, if you are producing a good and you can’t generate enough revenue to cover production costs then you will continue to lose money and the shutdown decision comes into play.

You want to avoid the downhill slope and make money

You want to avoid the downhill slope and make money

Finally, we examined the equilibrium price. The point of equilibrium in the business is when  quantity demand and quantity supplied is equal. We looked at how sales would be affected by certain situations and how our equilibrium price could be found and adapted to. This is a common reality in the modern business world with competition constantly changing, prices continuously fluctuating, and situations commonly arising. We looked at the situations, and then found out what we could deduce about the equilibrium price. If you have a great day and sell-out of lemonade by lunch time, what happens?

The graph shows that the equilibrium price would be higher than her and she needs to raise her prices to avoid excess demand. She sold all of her goods too quick showing a large demand but a small supply, thus excess demand.

On the other hand, if your neighbor decides to open her own stand and sell iced tea, what would happen to the equilibrium price for lemonade? This situation is much different. The competition introduced causes the equilibrium price to be below yours. The seller needs to lower his or her prices to avoid excess supply.

All in all, this hypothetical demonstrated something that people see everyday in the business world. The simple example could have represented even large business’s ways of calculating profit. The activity was successful in helping me understand the application of many of the terms we learn in economics and very helpful in providing a real life example of how the study of economics is applicable.

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